Square Inc. Is Expanding Into Banking -- Here's Why

Square (NYSE: SQ) has expanded far beyond its roots, when its business primarily consisted of transaction fees from payments on its small, white mobile card reader. It has launched numerous point-of-sale systems, peer-to-peer payments, working capital loans through Square Capital, customer relationship management (CRM) tools, payroll services, and more.

But Square's "flywheel" expansion isn't over yet. The financial-technology (fintech) company is submitting an application to form a wholly owned bank, The Wall Street Journal reported this week. Here's why investors should pay attention to this move.

Image source: Square.

Square Financial Services Inc.

If the application is approved, Square's new banking arm will be called Square Financial Services and will be capitalized with $56 million, the WSJ reported. The bank would serve businesses, offering loans and deposit accounts. WSJ's Peter Rudegeair asserts that Square plans to keep its consumer-facing financial products separate.

While Square doesn't yet boast a wholly owned bank, the company is no stranger to the industry. Square's current lending business, Square Capital dishes out small business loans and cash advances through a deal with Celtic Bank. Further, Square co-founder Jack Dorsey was quick to remind investors on Twitter this week that Square has already dished out a total of $1.8 billion in loans to over 140,000 small businesses. 

A quick glance at Square's most recent quarterly shareholder letter highlights how strong the opportunity is for the company in banking. Square Capital's quarterly loan volume skyrocketed in Q2, up 68% year over year to $318 million. This is up from $189 million in the second quarter of last year and $85 million in the second quarter of 2015.

Comprehensive fintech solutions

But Square's decision to launch its own bank is likely about more than its growth opportunity for loans. The move reflects Square's growing interest in offering a full suite of fintech products for its customers.

To this end, Square's banking application was specifically for a so-called "industrial loan" entity, or a structure that allows for more flexibility than just banking. Indeed, Square Capital lead Jacqueline Reses, who will be the chairman of Square Financial Services, told WSJ that its industrial loan entity application reflects the fact that Square has numerous business solutions beyond banking.

Image source: Square.

Square will likely view business banking as a way to get its customers more deeply entrenched into its expanding ecosystem of products and services. "[W]e see that sellers who accept Square Capital often use other services in our ecosystem," Square explained in its second-quarter shareholder letter. Management went on to cite an example of a photography darkroom business owner Lucia Rollow, who first started using Square as a medium for mobile payments. But as bookings increased, she used Square Capital to expand her darkroom space by 50%. Now Rollow has hired her first full-time staff member and uses Square's Payroll service.

Looking ahead, if Square becomes a wholly owned bank, it will likely leverage the entity to both scale its loan business and further fortify its fintech ecosystem.

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Daniel Sparks has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Twitter. The Motley Fool owns shares of Square. The Motley Fool has a disclosure policy.

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